ON THE HOMEFRONT; Pop Psychology

By ROGER LOWENSTEIN

Published: March 18, 2007

It has become common to refer to sharp escalations in asset prices as ''bubbles,'' and we know what bubbles do -- they pop. There are people who think we have a bubble in real estate going, and no wonder. Prices have been going through the roof. Forget (for the moment) home prices. An office building in Allentown, Pa., just went for the kind of change you could formerly expect for Midtown Manhattan, and in Gotham itself, where $400 a square foot was until recently a kingly price, the $1,000 threshold has been broken. While this is interesting to anyone who owns an office building, I personally do not know any such people, although I am certain they must be very rich. I do, however, know a goodly number of homeowners, and every one of them seems to be wondering the same thing: Are we going over a cliff?

Since last year, when new home construction stopped in its tracks and the rate of home sales (in hot markets) dropped by a third, the experts, the real estate writers, the listing agents, have been listening very hard for that popping sound. Prices have eased -- by a point or two in many markets, by as much as 5 percent in Boston. Prognosticators have forecast a recession, with banks up to their eyeballs in foreclosed mortgages and ordinary folk bailing out of their center-hall colonials.

Such alarmist sentiment is at odds with the conventional, and comforting, view: that real estate is ''different'' from other, purely financial markets, and that a house, in particular, is a more reliable investment than a dot-com stock. But is it?

The notion that we are on the cusp of a crash in housing in fact has its roots in the Nasdaq bust. Early in 2001, as the tech slide deepened, Alan Greenspan began to furiously lower short-term interest rates, eventually taking them to 1 percent. Presumably, that helped ease the recession. But housing prices began to surge. Robert Shiller, a Yale economist and critical observer of the housing market, says that home prices doubled between 2000 and 2006. On the coasts and in certain ostensibly desirable places to live (like Las Vegas), they did much better. Cheap money, courtesy of the Fed, was deemed responsible -- even culpable. In many quarters, Greenspan was essentially accused of cheating the country out of the depression we deserved: instead of allowing the swooning Nasdaq to bring down the United States economy and punish us for our sins, he had rolled the tech bubble into a housing bubble and allowed the party to go on.

The causality is by no means proven (mortgage rates, after all, are influenced mostly by long-term interest rates, over which the Fed has no control). But we are getting ahead of ourselves. Just which factors determine housing prices -- interest rates or psychology or maybe the price of aluminum siding -- is a matter for debate. What is certain is that in 2006, housing prices topped and began heading south.

Many experts believe that prices will continue to fall but not ''too much.'' This is no reason for relief: economists generally do not predict crashes until they have happened.

On the other side, the most forceful proponent of the bubble analogy is Shiller, who made his name by predicting that the stock market would crack. Shiller has been writing and speechifying that housing prices are due for a ''huge'' fall, possibly on the order of 50 percent. He and Karl Case, an economist at Wellesley College, have constructed indices of housing in 20 United States markets for the purpose of letting people bet on housing futures just as they do on soybeans or, as he put it, to ''protect'' themselves -- presumably against the approaching apocalypse. (These housing futures began trading last May on the Chicago Mercantile Exchange.)

Shiller's gloominess has been widely noted. He thinks we are under the spell of that familiar goblin, mass psychology. Lemming-like, people are buying homes merely because they expect that prices will rise. This certainly holds for speculators, like the manager of a rental-car agency at the Tampa airport who confessed to a customer (an economist) that he owned no fewer than 20 condominiums. And it explains some of the impulse to buy second homes, which are closer to being tradable assets than a primary residence is.

Shiller has been surveying ordinary homeowners, however, and he says that they, too, have fallen victim to irrationality, much as Internet investors did. He suggests that once reality sets in, prices could drop in a hurry, instead of slowly unwinding.

There is no doubt that most homeowners think they are living in an appreciating asset. The fact that people buy homes even though rentals are relatively cheap (in Boston, for example, rents have scarcely risen at all in the last decade) implies that buyers willingly pay for the privilege of ownership. But does this mean they are behaving irrationally?

Home prices do go up, although most people would be surprised at how slow the appreciation has been. According to the National Association of Realtors, housing prices traditionally rise two points faster than inflation, a relatively modest rate. And even in the past two decades, a period that includes the recent boom, anyone who owned a diversified portfolio of stocks handily outperformed American housing, even in markets like New York.

So how have so many Americans been able to convert their nests into (sizable) nest eggs? Most people who buy homes would not be able to tell you -- but they have profited from it all the same.